Rate cut: Desperate times; desperate measure

These are challenging times. The corona crisis is having a big impact on psychology and economy. Lockdown has completely changed consumer behavior. Demand is plummeting. Various economic sectors are paused. No one knows when, if at all, will they revive.  Immediate reduction of 150 bps would not have much immediate impact on businesses debt repayment as these are likely to be deferred (or restructured) soon. This might not be enough to boost stock market. Consumer is anyways, not leveraged in formal banking system.

BR Research had anticipated a rate cut before May announcement as it was clearly indicated in last week’s policy statement. The thought process could had been to wait for March inflation to be tamed before making a decision credible. But with every passing day, the pressure by businesses and market punters was increasing on PM and other authorities to push SBP to lower rates. Such pressures are seen in other economies. Fed was pressurized by Trump. Pakistan is no exception.

Could it be coincidental that PM’s fiscal package and monetary policy emergency meeting was called at a same time? The Monetary Policy Committee had to adopt the unorthodox measure. The fiscal measures taken would lower inflationary expectations such as reduction in petroleum prices and reduction in taxes on food items. This, along with a sizeable drop in global commodity prices will bring inflation down.  But sharp decline in supply can actually increase inflation too. It would have been best to wait for a few more weeks.

But the decision of lower rates was on cards. Based on pure economics, earlier decision has less implication. In developed and other economies where consumer credit is high, the mass level panic was anticipated as people could have defaulted on mortgage and credit card payments. Every business there is leveraged. In Pakistan, the pressure of business groups was not really called for. Large pool of consumers in Pakistan has informal credit and most SME businesses are financed by suppliers and other informal sources. The informal rates have little to no correlation with policy rate. Hence, reduction in rates has no direct bearing on them.

One implication of this sudden rate cut would be on currency. The PKR may come under pressure. Hot money is going out anyways, the outflow may speed up. There are already evidences that remittances flow is facing slowdown. Exports orders are being cancelled or are on hold. There will be savings from imports. This may subside some pressure in interbank market.

A more important decision for SBP is to ensure higher liquidity in banks through regulatory easing. One option is to lower minimum saving rates for the time being. The SBP should not give blanket deferment of debt payments as this could create moral hazard. It should be left to banks.

Bottom line is that policy rates are on now at 11 percent.  The SBP has not ruled out any other emergency meeting before May. But chances of that happening are thin.  The focus should be on firefighting in days and weeks to come. The provisioning of BISP stipend to higher number of families was required. Rs3,000 per month is low, but every drop counts. Now is the time for private sector to put hands on deck. Companies CSR’ and private philanthropies should join hand with the government to work on feeding those who cannot afford.